As a site coordinator and quality reviewer at a local Volunteer Tax Assistance site, I am able to see hundreds of real-life examples of “cause and effect”.
What EFFECT will cashing out my 401k have on my taxable income? It may CAUSE a portion of your Social Security taxable.
What EFFECT will $24,000 of income (with no withholdings) have on a 19 year-old full-time student living at home? The EFFECT will be felt by the student who will owe taxes and by the parents who will not be able to claim the child as a dependent.
The most recent unpleasant EFFECT was CAUSED by gambling winnings. A very lucky woman in her 70’s received a W-G from a local casino, indicating she won $20,800 worth of winnings with NO taxes withheld. The fact that no taxes were withheld did not bother her because she also had documentation showing her losses, which far exceeded her winnings. She knew that her losses could be deducted from her winnings. What she did not understand was…
She could only write-off the losses that were equal to her winnings…meaning…of the 25,000 of losses she had incurred trying to win the $20,800, she could only write off 20,800.
What she also did not know was…The losses are reported on a schedule A, while the winnings are counted as income. Once the winnings were added to her pension income and the $26,418 of social security income, she discovered that, not only had the winnings pushed her into a higher tax bracket, her income now was high enough that $13,661 of her Social Security was now taxable. Last year, with no gambling winnings, none of her Social Security was taxed.
It was only after her total income was calculated that she could subtract her itemized deductions (which included her gambling losses).
The combination of increased income (due to gambling winnings), plus the increased tax bracket, plus the increase in the taxable portion of her social security, and the fact that there were no tax withholding on the gambling winnings; this woman owed more than $2000 for her federal tax return…something she had not anticipated.
Before doing anything different with your money, it is important to stop and consider what effect it will have on your tax return.
As a volunteer tax preparer with VITA (Volunteer Income Tax Assistance), I frequently wish people understood taxes better. In recent weeks I’ve done three tax returns for people who, in their first year of retirement, cashed out their entire IRA or 401(k) account (ranging from $15,000 to $60,000).
In most cases, these new retirees used the funds for their long-term benefit – major home improvements and other purchases that will help them in the long run. I think they probably thought about the fact that spending the money now means they’ll live on more limited income for the rest of their lives, and they decided that was okay with them.
But I do NOT think they understood the tax implications of their decision, and I found myself wishing I would’ve had the chance to explain it all before they decided to withdraw the whole amount at once. Here are some things retirees should know:
Withdrawals from “traditional” IRA, 401(k), and similar retirement plans will generally be included in your taxable income. Large withdrawals can easily move you into a higher tax bracket, meaning that you pay a higher tax rate on some of that income. For a single person, income above about $53,000 is typically subject to a 22% tax rate, rather than the lower 10% or 12% rate.
The first year of retirement is especially tricky for income tax purposes, because usually the person also had employment income for part of the year, which may contribute to bumping them into a higher tax bracket.
Social Security income is only partly taxable (at most 85% of it is subject to tax). How much is taxable depends on how much other income you have that year. When a person has very low income, none of their Social Security income will be taxable; as their income increases, the portion of Social Security subject to tax also increases. That means that large withdrawals from retirement accounts can create a double-whammy by increasing the taxable amount of Social Security as well has increasing total income.
I know that some of the clients I served paid at least $5,000 more in income tax than they would have if they had spread their retirement plan withdrawals over five years, or even over two or three years. I’m also pretty confident that they did not really understand the tax impact when they made the decision to withdraw it all at once.
Bottom line? Before making decisions about withdrawing from retirement plans, consider various options and get information from someone who is knowledgeable about taxes. If you don’t have a tax expert to ask, try using IRS form 1040-ES (estimated taxes) OR the IRS online withholding estimator to compare different options. Note: remember to consider state income taxes, as well.
Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.
The Secure Act was originally written to make changes to retirement laws. The act passed through the House last May and was held by the Senate until November when it was added to the Appropriations Bill and signed into law in December.
The law change catching attention is the starting age for required minimum distributions (RMDs). If you are retired and reached 70 1/2 before the end of 2019 you are required to take distributions. Everyone else can wait until the year they reach age 72. The annual RMD amount continues to be based on life expectancy tables published by the IRS.
The other change attracting attention relates to distribution rules for inherited retirement accounts. These accounts, including IRAs, 401(k)s and other similar qualified accounts, generally have named beneficiaries. When there is just one beneficiary and it is the spouse, then the withdrawal rules are the same as if the account originally belonged to the spouse. The SECURE Act did not change this.
However, when the account beneficiary is not the spouse, the rules for taking distributions have changed. In general, the beneficiary must take distributions on a schedule that will liquidate the account within ten years. Stretch IRAs, which set up for distributions over the beneficiary’s life expectancy, are no longer an option. Beneficiaries will want to plan for the tax implications of those distributions.
Exceptions to the ten year distribution schedule include: disabled beneficiary, chronically ill beneficiary, beneficiaries not more than ten years younger than the deceased, and children that have not reached the age of majority. Separate rules apply to these individuals, and also to situations where multiple beneficiaries are named, so professional guidance is recommended.
More about the Secure Act will follow in subsequent posts……
Welcome to part two of our review of the the Secure Act! We’ll introduce you to some of the other retirement plan changes employees can expect to hear about as new rules and options are added to their plans.
A part-time employee who has worked a minimum of 500 hours each year for three continuous years can now begin making retirement savings contributions to an employer’s retirement plan. This change expands eligibility beyond the old rules that allowed an employer to use a 1,000-hours-worked rule before full time employees are allowed to participate in a retirement plan.
New tax credits are available for small business owners who start a retirement plan for their employees. Additional credit is given if the plan uses an automatic enrollment structure. The additional business tax credit is also available if an existing plan is converted to automatic enrollment. The business tax credits range from $500 to $5000 and can be claimed for three years. Small employers can also participate in multiple-employer plans that allow many unrelated businesses to join together to share costs of plan administration.
Old rules allowed employers to include annuity options in their 401K plans, but if the insurance company selling the annuity contract failed, the employer was required to guarantee the continuation of the contract payments. The Secure Act removed the employer’s responsibility to protect retirees. The inclusion of annuities in retirement plan menus is expected to increase.
The cap for auto enrollment contributions to an employer’s retirement plan was 10% of employee pay; the amount has been raised to 15%. Employers must continue to give employees the option, once a year, to change their contribution.
The Secure Act also removes the restriction that prohibited individuals age 70 1/2 or older, who are still working, from making contributions to an IRA.
In our next post we will visit some of the non-retirement changes included in the new Secure Act.
Eligibility for participation in retirement savings plans, incentives for small businesses to establish retirement plans, and rules for contributions and distributions are the main focus of the Secure Act, but there are other changes worth understanding in the new law.
Loans allowed by an employer from retirement funds can no longer be distributed through a credit card account or similar arrangements. If received through a credit card, the funds must be claimed as income and are subject to taxes and penalties.
Withdrawals from retirement accounts can now be made for the birth or adoption of a child within one year of the event. The limit is $5000 per account owner and it has to be claimed as income, but there will be no penalty tax added.
At least once a year, your retirement account report must include a statement of monthly benefits the owner can expect in retirement. The amount will be based on a single lifetime or joint lifetime annuity.
403B and 457 plans have new rules for transferring account funds to a new employer’s plan or to a qualified plan distribution annuity.
And in areas unrelated to retirement accounts:
529 plans can now be used to cover the costs of registered apprenticeships, homeschooling costs, private elementary, secondary and religious schooling. Up to $10,000 can be used to repay student loan debt. (State alignment is necessary so check your state rules.)
The Kiddie Tax on unearned income is being reset to rules in place before the 2017 TCJA law. Under TCJA, unearned income was subject to the Estate or Trust tax rates. Amended returns can be filed for 2018.
The penalty for failing to file a tax return is a maximum of $400 or 100% of the tax due.
Rules and implementation guidelines will further define these changes, so check with financial professionals and your employer’s HR departments for more details.
My husband is retired, so he has more opportunities to spend time in the repair shop waiting for tires to be patched or equipment to be repaired, all the while chatting with his peers. Those conversations result in questions for me when there has been a discussion about finances. The topics of inquiry are usually related to estate planning. The average age of farmers is 57.5 years, so it stands to reason it wouldn’t be about student loans, and he doesn’t need answers when the topic is commodities, livestock or equipment sales.
The most recent ask was the result of a statement concerning a tax liability of 38% if farm ground was sold. “That’s probably wrong” I said, and here is why:
Only property owned for less than a year is subject to regular income tax rates.
The 2019 tax rates on regular income is 10%, 12%, 22%, 24%, 32%, 35%, and 37%
The owner would be able to subtract costs and would only pay taxes on the profit. Farm ground has actually gone down in price or stayed stable during the past year.
Income taxes are graduated and rise as your income increases. All single taxpayers pay 10% on the first $9,700 of taxable income. The 37% income tax is calculated on income greater than $510,301.
If the farm ground was owned for more than a year then profits from sales would be subject to long term capital gains taxes instead of regular income taxes.
Long term capital gains taxes are 0%, 15%, and 20%.
The tax rate would be determined by income. A single taxpayer with income of $39,375 or less pays 0%, 20% is the capital gains rate when a single taxpayer has income greater than $434,551.
If the farm ground had a house on it and the owner lived in it for two of the five years before the sale, then up to $250,000 of profit resulting from the home sale would be exempt from taxes.
There could be an extra tax as a result of the Affordable Care Act. A 3.8% investment tax is collected when a single taxpayer’s investment income exceeds $200,000.
It was suggested that I mail Extension materials from Ag Decision Maker or Money Tips to the repair shop visitor!
The Tax Cuts and Jobs Act was passed in 2017. The legislation increased the amount that is exempt from federal estate taxation. Between 2018 and 2025 the amount exempt from taxes is $11,180,000 for singles (more than $22 million for couples) and is adjusted for inflation each year after 2018. In 2026 the amount will fall back to $5,400,000. A majority of individuals will never exceed either amount; however, estate planning is more than avoiding estate taxes. Some decisions about property transfer can have other tax consequences. Changes in tax law can make old estate plans obsolete.
One important element of estate transfer is the “step up” in basis of real estate and other property that has gained value over time. An acre of ground purchased for $200 (original cost or basis) in 1984 could have a value of $4000 or more in 2019. If the property were sold it would be subject to capital gains taxes on the $3,800 of appreciated value. If the property is inherited, it passes without taxation and the basis is reset to the market value the day the owner died. This “stepped-up basis” is a key consideration when decisions are made about gifting property, setting up trusts, and developing other estate transfer plans. Example: suppose you gave your daughter that acre of land today. Upon selling the land, she would owe income tax on the $3800 capital gain; if she had received it as an inheritance after your death, the sale would involve little or no capital gain, saving her the tax bill.
Transfer of wealth through estate plans has also resulted in new requirements for reporting and keeping records on appreciated property (real estate, stocks, etc.) with a stepped up basis. New IRS rules define the property subject to appraisal, steps to ensure accuracy, and required reporting to the IRS and beneficiaries. Executors are responsible for date of death appraisals. Appraisals must be kept by the beneficiaries and used if the property is sold. It is wise to complete the date of death appraisal promptly; the IRS is more likely to question an appraisal that is completed a long time after the death of the owner. Details are included in IRS Form 706.
Ag Decision Maker is an Iowa State University Extension source of additional estate planning resources and information. Scroll down the page to find estate planning publications.
It’s April 16 and most of us survived another tax season. Were you happy with your refund or did you have to pay in more than you have in the past? If your refund was too big, or you had to pay in a lot, you may wish to revisit your Form W-4.
Every time you earn income, you’ll most likely owe state and federal income tax. Your Form W-4 determines how much tax is withheld from your paychecks. Your employer deducts taxes based on the number of allowances you claim on your W-4. This system works well if you’re a “standard” taxpayer who files single, has one job, and claims a standard deduction. But if you don’t fit into this category—and many of us don’t—it’s likely that you have too much or too little tax withheld.
Workers complete form W-4 when they start a job. For many people, that is the last time they pay attention to it. Has there been a change in your household – did you add a child, get married or have a divorce, change jobs or did your spouse get a job? Any of these changes may impact your tax status; that means reviewing your form W-4 is a good idea. In addition, changes in tax law may affect your ultimate tax bill; after passage of the most recent federal tax bill in late 2017, some workers consulted with the payroll office of their employer to review their allowances.
When you have too much money withheld from your paychecks, you end up giving Uncle Sam an interest-free loan (and getting a tax refund). Ask yourself if there are better ways to use that money. Why not take home more money in your weekly paycheck? Or invest the proceeds and earn interest on it? On the other hand, having too little withheld from your paycheck could mean an unexpected tax bill or even a penalty for underpayment. Either way, there’s a better way to manage your hard-earned money.
The key to having the right amount of tax withheld is to update your W-4 regularly. Do this whenever you have a major personal life change. For people who wish to avoid providing that interest free loan to the government, the goal is to file a tax return with zero refund and zero owed. While it is rare to get an actual zero as a result, these folks are generally happy if they either owe a small tax bill or receive a small tax refund. If you count on a big tax refund every year, you should also pay attention to your withholding, because how much you have withheld directly impacts your refund.
Is it time to call your employer’s payroll office?
Resources are important whether you are looking to rent your first apartment, pay your bills, buy your first home or send your child to college. There are many ways to save money to reach your goals, and hopefully ISU Money Tip$ will be one of them. I enjoy traveling, needlework and am a novice gardener.
Social Security numbers have to be correct on tax returns. At the Volunteer Income Tax Assistance sites we receive an immediate reject on the return if the name and numbers don’t match Social Security records. We also receive a reject code when a social security number has already been used on a tax return. Individuals must still file a return, but with the electronic submission blocked, it must be a mailed copy.
The IRS and Iowa Department of Revenue will send you a letter saying more than one return was filed in your name. Be sure to respond to the letter promptly. Use the internet to validate the IRS phone number and address (scam artists are now creating very good look alike letters). Call and discuss the evidence needed to support your tax return submission.
A letter will also be sent if the IRS or Iowa Department of Revenue has a record of earned income that you didn’t report on a return. It may mean your SSN was used by someone else so they could avoid paying taxes on their earnings.
Social Security numbers can be obtained through scams or by buying numbers that were stolen in a security breach. If you have been notified that someone has committed tax-related identity theft with your personal information, report it promptly. Go to identitytheft.gov to complete and send the IRS Identity Theft Affidavit. By doing this, you will also file a complaint with the Federal Trade Commission and obtain an ID Theft Recovery Plan.
After your identity is falsely used for tax purposes, the IRS will send you an annual PIN number (a new number each year). This PIN number will be added to your tax return to verify your identity to the IRS, and will prevent anyone else from continuing to use your social security number on false claims.
Let’s be truthful, some of us do an excellent job helping our 17-18 year old get ready for the real world even if we also remember situations when we hope they didn’t pay too close attention to our bad habits. Adult finance is complicated by some natural tendencies toward spending and savings. I’ve heard more than one parent wonder out loud how a child could grow up in their house and manage money the way they do.
Whether you have full confidence in their money management skills or expect to get several calls asking for guidance when the issue is totally out of hand, here are some tips that may help you and the 17-18 year old in your life:
Reduce their risks-
Review your insurance policies and find out if the coverage extends to include their property while they are living away from home temporarily. If they are leaving home permanently, pick up information about renters policies and explain it to them.
Share tips about auto insurance coverage. Remind them that valuables in the vehicle are not insured. Consider whether it makes financial sense to have them insured through their own policy. If the premium will exceed 10% of the value of the vehicle, it may be time to switch to liability only.
If they will continue to be covered by your health insurance plan: 1) confirm they will have access to the network providers; 2) make sure they are carrying an insurance card; and 3) share a quick reminder of typical preventive services and what to plan for co-pays.
Recommend filling out their W-4 with a 0 for withholding exemptions until they have filed their first tax return. Several part-time jobs combined together can result in underpayment of taxes due.
Consider giving them a list of the records you save, electronically or on paper, for financial reasons.
Give them a shredder. Not an exciting gift, but important to keep their identity intact.
Keep the door open for conversations without judgement. We’ve all done stupid things with money – why not make sure the young adult learns some lessons from you and not the hard way.